Portfolio Update: Everything is awesome (for now)…Part I

To supplement the recent portfolio updates on some key positions, OM wanted to talk about his ‘market view’.  He’d normally spare y’all from this but it seems appropriate since the portfolio is the ‘riskiest’ it has ever been.  While OM’s broker’s limited metrics don’t show it, OM thinks of the positions in Brazil, Argentina, Greece and Uranium as being rather correlated and thus the portfolio is riskier.  In addition to the prevalent Emerging Markets risk, all are situations where the broad theme is similar; an element of stress/distress but a combination of fundamental valuation support and catalysts to change investor psychology offer opportunity.  Given the size of these positions, and the risk, Our Man is going to touch on the macro outlook, and then on valuation and psychology to hopefully explain why he’s so comfortable (at the moment).

Macro Outlook

Let’s not bury the lede, as we enter 2018 everything is awesome…

Our Man is a firm believer that recessions and crises don’t come from nowhere, and that there are warning signs for those who are willing to look.  This does not mean that recognizing the warning signs will be easy, and there will be mistakes along the way, but it behooves us to try.  With regards to the US, current data is uniformly rock solid; OM has posted the GDP graph below, but you could look at jobless claims, average hourly earnings, unemployment, inflation, etc. and the story would be the same.  Yes, most of these are lagging/coincident data (i.e. tells us how the economy was/is doing, not how it will do) but there’s no hint of a breakdown.

In terms of forward looking macro data, OM has historically found the Chicago Fed’s National Activity Index to be helpful and timely; it shows no sign of decline.  This is supported by other leading indicators out there such as the St. Louis FED's Leading Index for the US, the Conference Board’s Leading Economic Index and the Philadelphia FED’s state leading indexes.

The best market-based measure for recessions has been the inversion of the yield curve - when long-term Treasury yields are lower than the short-term ones - as it has been an accurate historical forecaster of past recessions.  The US yield curve has been flattening for the last couple of years and it is now at a level last seen before the Great Financial Crisis, which some see as an early warning sign.  However, as the graph below shows, the yield curve has historically inverted well before (i.e. 1-year+) any recession.  Thus, with the yield curve flattening but yet to invert, OM thinks there is more than enough time to enjoy the sunshine.

To summarize, the US continues to enjoy a prolonged spell of economic growth and is enjoying a “beautiful normalization” following the crisis.  What changed in 2017, was that this became a global occurrence; 2017 was the first year since the crisis that the global economy was operating at full potential.  This trend was visible across all regions and different economies, with World GDP growth at 3.0% comfortably outpacing the World Bank’s June expectations (by 0.3%).  Special shout-outs to Japan, which has had its longest growth boom since 1994, and Europe, which has rebounded strongly and where PMI’s suggest continuation in the near-term.

There are legitimate concerns for investors, but for now the economy is not one of them.  EVERYTHING IS AWESOME!!!

[OM will be back with Part II on Valuation and Investor Psychology tomorrow]

Leading Indicators -- Japanese History and Current US

n the last post, Our Man mentioned that when equity and bond yields diverged in Japan stock market performance became more tied to economic cycle.  As such, going forwards, leading indicators should have greater value in helping us think about and control our equity exposure.  

Japanese Equity Performance and Leading Indicators

 

As the shaded areas hint, it seems reasonably conclusive that the leading indicators seem like a helpful tool and it would be wise to strongly consider reducing exposure when the leading indicators appear to be topping out.

Now, clearly, Our Man is not unaware of the pitfalls of using the leading indicators (such as “how does one define topping out in real-time”) or suggesting that they be the sole determinant of one’s exposure (because that would be moronic!) but is merely suggesting they’re another useful tool in terms of thinking about exposures.

Why bring this up now?  Well, let’s look at what’s happening to the US Leading indicators:

This certainly looks like some form topping out to Our Man, which would suggest that at the minimum that the easy money has been made in terms of a pure directional move.